Method of Accounting: The Importance of a Company's First Filing of its Tax Return

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First of all, the truth about professional tax software is that it automatically selects the cash method of accounting for all business returns that you file.

However, the single most important election you make on the initial tax return is the method of accounting. Cash is most commonly used because on the taxpayer’s books, they will have accounts receivable, and the tax preparer will justify the use of cash because they won’t have to claim as income money the company never saw.

This effectively lowers the taxable income because the receivables aren’t taken into account. If for some reason, down the road, it becomes more tax advantageous to use another method of accounting, you have to File Form 3115 and get approval from the IRS to change the method.

If you think about it, by filing Form 3115 with the IRS to change the method of accounting you are basically telling the IRS that you have never counted income and expenses correctly. And the change you are requesting will clearly reflect the income and expenses.

I don’t know about you, but my thoughts of filing this form is that you are drawing attention to every previously filed tax return because income and expense were never reflected in the correct way, and the IRS may decide to audit those previous years to see what was wrong with them.

Before I file the first tax return for a company, I will have a conversation with the business owner about their business, where I ask them about their one-year, five-year, and ten-year plans. Most clients use an accounting system like QuickBooks, and all they will keep track of are their invoices in the system. Rarely will a company keep track of accounts payable. Therefore, selecting cash just based on these statements is borderline malpractice. 

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About Craig W. Smalley, EA

Craig Smalley

Craig W. Smalley, MST, EA, has been in practice for almost 23 years. He has been admitted to practice before the IRS as an enrolled agent and has a master's in taxation. He is well-versed in US tax law and US Tax Court cases. He specializes in taxation, entity structuring and restructuring, corporations, partnerships, and individual taxation, as well as representation before the IRS regarding negotiations, audits, and appeals. In his many years of practice, he has been exposed to a variety of businesses and has an excellent knowledge of most industries. He is the CEO and co-founder of CWSEAPA PLLC and Tax Crisis Center LLC; both business have locations in Florida, Delaware, and Nevada. Craig is the current Google small business accounting advisor for the Google Small Business Community. He is a contributor to AccountingWEB and Accounting Today, and has had 12 books published on various topics in taxation. His articles have also been featured in the Chicago Tribune, New York Times, Yahoo Finance, Nasdaq, and several other newspapers, periodicals, and magazines. He has been interviewed and been a featured guest on many radio shows and podcasts. Finally, he is the co-host of Tax Avoidance is Legal, which is a nationally broadcast weekly Internet radio show.

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